Rising oil prices threaten economy, experts warn

As the price of crude oil approaches record highs, the impact is beginning to flow far beyond the corner gas station.

It's slicing through the economy, cutting into corporate profits, raising the cost of food, airline tickets, delivery services and countless other products.

The cost of petroleum-based consumer goods -- everything from plastic wrap to Goretex to aspirin, luggage, surfboards and nylon stockings -- is expected to rise.

Combined with record gasoline prices at the pumps, the spreading energy inflation means that Americans will have less spending power -- which is likely to dampen the economic recovery, experts say.

For every $5 per barrel increase in the price of oil, roughly half a percentage point is shaved from the U.S. gross domestic product, economists say. Currently, that would be about $55 billion a year in lost production.

The economy is less dependent on oil than a generation ago, but if oil prices remain near current levels or higher, expensive energy is certain to be an increasingly serious problem.

"It does threaten the economy," said Lacy Hunt, chief economist at Hoisington Investment Management Co., an Austin, Texas-based money management firm. "We have not done well with oil shocks."

Crude oil futures rose yesterday to nearly $40 a barrel on the New York Mercantile Exchange, before settling at $39.37, down 20 cents from the day before. On Wednesday, the benchmark crude contract hit a 13-year high, closing at $39.57, the highest closing since October 1990, during the buildup to the Persian Gulf war.

Oil is still cheaper, adjusted for inflation, than during a spike in the 1970s, but the outlook is more ominous because of voracious global demand, limited reserves and potential supply disruptions in the Middle East.

Federal Reserve Chairman Alan Greenspan warned in a recent speech that "dramatic increases" in oil and natural gas futures prices could "significantly affect the long-term path of the U.S. economy."

"You ain't seen nothing yet," said Douglas G. Ober, chairman and chief executive of Petroleum & Resources Corp., a Baltimore-based closed-end mutual fund. "While we will see seasonal dips, we will see a general upward trend as long as the Chinese economy is growing at 8 percent or more."

The pain is already apparent in some sectors of the economy.

"I think we are seeing it in higher food costs, higher transportation costs and vacation costs," said Phil Flynn, senior market analyst at Alaron Trading in Chicago. "We've seen some companies [report] that higher energy costs are going to be cutting their profits."

For troubled airlines that have already cut back thousands of employees because of travel disruptions in the post-9/11 era, a jolt in energy prices could mean more losses and layoffs just as an economic recovery is starting to lift business.

American Airlines has announced plans to raise fares by $4 per round trip within the United States because of climbing jet fuel prices.

Other large airlines have tacked on fuel surcharges, but only in markets where they have no competition from low-cost carriers, said Tom Parsons, chief executive of bestfares.com, a consumer-oriented Web site that tracks airline fares.

David Castelveter, a US Airways spokesman, said every penny increase in the cost of jet fuel costs the carrier about $11 million. Like other airlines, US Airways has added surcharges to some flights.

Shipping packages also is becoming more expensive.

United Parcel Service has passed along higher costs to customers because fuel costs have risen more than 13 percent in the first quarter from a year earlier.

The cost of jet fuel for UPS aircraft has spiked even more sharply than the diesel fuel used by its trucks. In January, the company began adding a fuel surcharge to its air express and international express services. It now costs 6 percent more to ship a package by air.

Nowhere will rising energy prices be felt more than at the gas pump. Experts see gas prices moving as high as $3 a gallon this summer. In some states, including Maryland, gasoline is now averaging $1.80 per gallon for regular unleaded, with some stations charging $2 a gallon or more.

"This is money out the door," said John Kilduff, senior vice president for energy risk management at Fimat USA in New York, a global commodity brokerage. "This has been very painful for the consumer. ... It's worse than a tax increase because it's a transfer in wealth, not a road paved or a budget deficit paid down as a result."

Oil prices are moving toward records heights for a number of reasons. Worldwide demand is exploding as the economies of China and India expand. While consumption is increasing, supply is tightening.

"We know that the bulk of the world is not increasing its production of oil, that the bulk of the world is barely replacing the oil that it is using," Ober said.

Oil refineries have neither expanded operations nor been upgraded to keep up with demand, experts said.

"When was the last time a refinery was built in the U.S.?" Ober said. "It has been a long time."

Paul Roberts, author of The End of Oil, agrees that the trend in oil prices will be upward. Conventional wisdom, he said, was that the price of oil would fall after the ouster of dictator Saddam Hussein and the end of the Iraq war.

"That is not happening," Roberts said. "What is really going on ... is the end of cheap oil."

He said Saudi Arabia's "spare capacity" has fallen and that discoveries of new reserves outside the Middle East are declining.

"The world outside the Middle East looks like a pin cushion," he said.

Demand for fuel has risen as people continue to live farther from the cities where they work and drive longer distances. And low interest rates have spurred consumers to buy more SUVs, minivans and trucks.

"People have bigger and more gas-consuming vehicles," said John Person, a chief analyst at Infinity Brokerage Services in Chicago and editor of "The Bottom-Line Financial and Futures Weekly Report." "We're entering the peak season for driving."

As gas prices move to record highs, most people will cut back on driving, Person predicted. He said prices of crude oil could rise to $47 a barrel.

"Prices are going to get higher, and we're going to have to get used to them," he said.

Hunt, the Hoisington economist, called the spike in oil "very troubling."

If prices continue to rise, the economy could slip back into recession, he said. Since 1970, there have been four oil shocks, and each time the nation has ended up in recession, he said.

"The implications for the economy are going to continue to worsen if the oil prices are not reversed," Hunt said. "The oil shock is clearly an unwelcome development."